Educational Articles

Stock Screen: Highest Yielding REITs - January 29, 2014

Michelle Jensen
| January 29, 2014

There are a few sectors and industries that income investors can turn to, virtually without fail, to find above average dividend yields. Real estate investment trusts, commonly referred to as REITs, are one such industry (others include utilities and limited partnershipsThe high dividend payouts in the REIT sector relate to two aspects of these securities. First, REITs, as their name implies, own real estate or real-estate related securities (in the case of mortgage REITs). This asset type is known for its cash flow generation. Second, REITs are structured as pass through entities for tax purposes. This allows these companies to avoid corporate taxation, but requires that the vast majority of earnings be “passed” on to shareholders as dividends. Potential investors should note that dividends shareholders receive from a REIT are taxed as ordinary income.

Just because REITs, in general, have a tendency to pay material dividends, doesn’t mean that all REITs do. Just as with other sectors, some REITs are geared toward growth and others toward income. To highlight those that fall into the latter category, we used the online screening tools of The Value Line Investment Survey to highlight those REITs with yields above the current median of 4.49%.

It is important to keep in mind that an above-average yield can be an indication that the market believes the dividend payment is at risk. That said, a high yield could also present a good buying opportunity if a company is merely misunderstood. The screen turned up several interesting REITs (see list below), including The GEO Group (GEO) and Corrections Corporation of America (CXW).

REIT Conversions

Real estate investment trust (REIT) conversions have become increasingly popular over the past few years. This trend has been prominent among tower, data center, storage, lodging/resort, infrastructure, billboard/gaming, and prison companies due to the many benefits that come along with the status. These include a more tax-efficient corporate structure (as shareholders are not subject to double taxation), better access to funding, and lower cost of capital. However, to qualify as a REIT, no less than 75% of assets are required to be real estate related, and at least 90% of its taxable income must be distributed to shareholders through dividends. The GEO Group and Corrections Corporation of America are two recent entrants into the REIT Industry. These prison-based companies, both of which converted to this new structure on January 1, 2013, should appeal to income-seeking investors due to their above-average dividend yields.

Corrections Corporation of America

Corrections Corporation of America is the largest owner of privatized correctional and detention facilities in the nation and also provides rehabilitation, educational, healthcare, food, and recreational services. The company owns or operates 53 facilities (with an additional 16 owned by government partners), containing approximately 90,000 beds, which are located in 20 states and the District of Columbia (as of September 30th).

The company likely struggled to create much top-line growth in the year just ended, largely due to declines in populations, specifically from the United States Marshals Service. This federal customer, combined with the Federal Bureau of Prisons and U.S. Immigration and Customs Enforcement, accounted for roughly 43% of September-period revenues. Still, we believe CXW’s prospects remain promising. Our optimistic outlook largely stems from management’s long-term strategy of utilizing capacity within its existing owned facilities. This would spur occupancy growth over the long haul. Occupancy levels have remained problematic for some time now, declining for six consecutive years, and have nestled in the mid-80’s range.

In order to comply with REIT rules, which require the company to pay its previously undistributed accumulated earnings and profits attributable to tax periods ending prior to January 1st, the board of directors declared a special dividend of $6.63 per share of common stock (paid May 20th). Moreover, the quarterly payout, which initially increased to a hefty $0.53 a share, was lowered to $0.48 a share. All told, these shares still offer a 5.8% yield, which stands well above the REIT industry median.

Nevertheless, momentum investors may want to keep a cautious eye here due to the stock’s Below-Average Timeliness rank (4).

The GEO Group

As a real estate investment trust, the GEO Group owns, leases, and manages correctional, detention, and re-entry facilities and provides community-based and youth services in the United States, Australia, South Africa, the United Kingdom, and Canada. The company operates under four segments: U.S. Corrections & Detention (67% of September-period revenues); GEO Community Services (20%); International Services (13%), and Facility Construction & Design (no operating activity).

This REIT clearly has room to grow. We expect revenues will increase at a healthy clip over the 3- to 5-year horizon through signed or awarded government contracts. Moreover, GEO has approximately 6,000 vacant beds on its roster, at six idle facilities. Indeed, the company is marketing these on local, state, and federal levels. The reactivation of these facilities could potentially add $125 million to the top line, while growing share net by $0.35-$0.40 over the long term. (This assumes the company’s 2013 rate and occupancy levels.)

At the recent valuation, these shares offer an attractive yield (by REIT standards) and hold the third-highest yield out of all REITs covered in the Value Line universe. The board of directors raised the payout substantially to $0.50 per share, following the REIT conversion, and increased the dividend another 10% during the fourth quarter, to $0.55 a share. Although impressive, we do not expect any additional increases over the next 3 to 5 years.

Company

Ticker

Dividend Yield

Annaly Capital Mgmt.

NLY

11.22

Hospitality Properties

HPT

7.27

Geo Group (The)

GEO

6.54

Digital Realty Trust

DLR

6.18

Mack-Cali R'lty

CLI

5.99

W.P. Carey Inc.

WPC

5.83

Corrections Corp. Amer.

CXW

5.78

HCP Inc.

HCP

5.71

Health Care REIT

HCN

5.68

Realty Income Corp.

O

5.67

Healthcare R'lty Trust

HR

5.39

Liberty Property

LRY

5.3

Washington R.E.I.T.

WRE

5.12

Ventas, Inc.

VTR

4.72

Duke Realty Corp.

DRE

4.53

At the time of this article's writing, the author did not have positions in any of the companies mentioned.